It seems like an ideal arrangement: Teachers working as independent contractors gain flexibility over their schedules and improve their cash flow. Studio owners add expertise and variety to class schedules as interest and enrollment warrant, by hiring ICs. The owners also reduce their costs significantly, since they don’t pay Social Security, Medicare, federal or state payroll taxes, unemployment insurance, worker’s compensation, health insurance, or for vacation and sick leave, as they would with employees.
This is a good thing all around, right? Not exactly, according to the IRS, state revenue authorities, workers’ comp boards and the Department of Labor. Like most things that sound too good to be true, the use of ICs isn’t always what it seems. In fact, quite often incorrect use of ICs is a direct violation of federal and state tax and federal labor laws.
How can an arrangement between two consenting parties be wrong? The difference between tax abuse and a winning arrangement is a matter of definition. If found on the wrong side, parties run the risk of being assessed back taxes and the studio owner may pay additional fines.
For studio owners, the tax savings can blind them to the disadvantages of using ICs. Because they are independent, these workers are free to come and go. By definition, they are not under the business owner’s control, and by law, they shouldn’t be. How they teach isn’t up to you. They can’t be fired. And because you aren’t paying workers’ comp, you bear the sole liability for any work-related injury. This is because workers’ comp is offered to employees in exchange for their right to sue their employer. But to an IC, you are the sole source for restitution. Also, an audit flag goes up for government agencies that target this area for review.
The key advantage to being an IC for teachers is flexibility. But this is possible through part-time employment as well. When you are an IC, job security and protection against unfair practices or discrimination disappear. Health insurance, unemployment benefits, workers’ comp and the opportunity for paid leave (for illness, vacation or even jury duty) are forfeited. If injured on the job, your only recourse for lost income is to sue the studio owner/client for negligence. You bear full responsibility for state and federal taxes—not to mention Social Security and Medicare, which are subsidized by employers, and therefore higher for the self-employed (this is known as the self-employment tax). While you can deduct business-related expenses, keep in mind that these are primarily expenses that your employer would cover. The only real tax break that the self-employed receive is being able to put away substantially more tax-deferred money for retirement than employees can.
Defining Your Identity
Just because a studio owner identifies a teacher as an IC doesn’t mean this definition is correct, even if it’s in writing. The key determinant is how “independent” the contractor really is. ICs who only work for one studio, for instance, might actually be employees—full- or part-time, depending on how the studio defines a full-time schedule (typically, anything over 32 hours a week, in a 52-week year, is considered full-time).
The IRS takes a rigorous approach to maintaining its distinctions. Though it doesn’t use a precise formula to determine when exactly one crosses the line between being an IC and an employee, it questions how a relationship is structured. (For a clearer understanding of IRS expectations, see the Q&A; below.)
But even the IRS doesn’t expect perfect compliance with its guidelines. They are most focused on the issue of control, which is the hardest for many studios and teachers to overcome, as Angela Floyd, owner of Angela Floyd School for the Dancer in Knoxville, Tennessee, has discovered. “In a ballet school, the owner makes the schedule. My understanding, at least in Tennessee, is that once I set the schedule for teachers to adhere to, they are my employees,” says Floyd. To avoid the risk of being caught on the wrong side of the definition, Floyd hires her teachers as part-time employees.
However, if teachers are visiting—teaching workshops or involved in a short-term project, and their primary draw is their expertise—then IC status is defensible. In such visiting-artist situations, the content of the class would be determined independently of the studio and that guest artist’s reputation would be the main attraction of the class. However, independence would be hard to defend with a substitute teacher who follows the curriculum guidelines determined by the studio.
Which One Are You?
Before pursuing the IC route, consult your tax advisors for guidance on your state’s requirements and about how best to structure these relationships. Understand that since agencies may not share these definitions, owners may need to treat the same worker as an IC for one government agency, and as an employee for another in order to be in compliance. If the studio, for instance, withholds federal taxes as though the teacher were an employee, but not state taxes, the teacher should be sure to pay the estimated taxes due the state. For the teacher, the main responsibility is making sure taxes are being paid on time.
Studio owners should consider requiring ICs to fill out an Independent Contractor Form, detailing their place of business, other client relationships, credentials and insurance coverage. For the owner, this helps document a legitimate IC arrangement. Owners should never let ICs fill out the same job application that prospective employees fill out. That would create evidence that the owner actually considered the IC an employee.
Create a written contract that describes what services will be provided, the hours of availability, the cost and what compensation will be due to the owner should the IC fail to perform satisfactorily. Include beginning and ending dates to avoid the appearance of employment and list what, if any, expenses will be reimbursed. The greater the responsibility an IC has for business (and travel) expenses, the more independent he or she appears and the greater the evidence he or she has personal money at risk. The following websites offer useful guidance for the structure and content of such a form:
Sticking to Status Quo
To maintain IC status, teachers should abide by the following rules:
- Do not ask for supervision or instructions on how to run your class.
- Hire and pay any assistants yourself.
- Invoice for your services using your own stationery, and keep records of payment.
- Have business cards and a business phone line as proof that your services are available to multiple studios. Offer this information to each studio for their records.
- Keep your business expenses separate from your personal expenses.
- Avoid being deemed a part-time employee by one studio and offering yourself as an IC performing the same duties elsewhere. It could lead the IRS to reclassify you.
- Pay taxes quarterly. Also, if you equate IC status with pocketing tax-free pay, rethink your strategy. If your client is tax compliant, and paying you more than $600 annually, they will be filing that information with the IRS, where it can be crosschecked.
Confusing an IC status with that of an employee can lead to government penalties. Make sure that you take
the time to sit down with teachers and owners (and ideally with their respective tax advisors) and clearly define the distinction and weigh the risks. A careful assessment now will save you time and energy later. DT
Q & A
The IRS uses these distinctions to evaluate the status of an IC:
Q: Does the worker receive instruction in how, when or where to do work, what materials should be used, which assistants to hire to help with the work or where to purchase supplies or supporting services?
A: ICs should set their own hours, have their own places of business and determine independently how they will get the job done. Note that in practice, the IRS seems to focus more on “how” than “when,” “where” or “with what.”
Q:Does the worker receive training or need to do the work in a certain way?
A: ICs use their own methods to accomplish the agreed-upon results.
Q: Does the worker’s involvement in the business impact its success or
A: The services a specific IC provides should be separate (i.e., the business can use them or not and still thrive).
Q: Does the worker have a continuous or exclusive relationship with
A: An IC is hired to do a project. There is no assumption of a continuous
relationship, nor should the relationship be exclusive—the IC is free to take on assignments from other clients.
Q: Do the workers have an investment in the work being done?
A: ICs need to have something at risk, like a reputation, that ties the work to them and not to the studio. The IC would also retain the copyright to his or her work (e.g., choreography) unless otherwise sold.
Q: Do workers bear the responsibility for all or most of their business expenses, or are they reimbursed?
A: ICs should not expect reimbursement.
Q: Has the worker executed a written contract that specifies the nature of the results expected by the client and the cost?
A: ICs operate under contract, a written document specifying the results
the client expects, timeframe and cost. Generally, payment by the hour is appropriate for employees; ICs are expected to price by the project.
Q: Can the worker realize a loss from the contract?
A: ICs bear the risk of doing business. This means they could theoretically
lose money dealing with a particular client due to poor decision making or nonpayment, for instance.
Q: Does the worker receive any benefits, such as insurance, pension or
A: ICs do not receive any benefits. Keep in mind, though, that simply
withholding benefits from workers who would otherwise be classified as employees doesn’t change their employment status.
Q: Can the worker be fired or have the right to quit?
A: ICs can’t be fired without financial consequence as long as they are
providing the results specified in their contracts, nor can they quit without
financial consequence, the way an employee can. The contract specifies the
liability attached to a job that isn’t well done.
Chicago-based freelance writer Gayle B. Ronan has written financial, investment, business management and tax-related articles for Bloomberg WealthManager, TICKER Magazine and www.CNBC.com.